Opinion: This stock market gauge predicts double-digit gain for S&P 500
'Best indicator you've never heard of' is bullish
The stock market's long-awaited correction is unlikely to be the beginning of a major bear market.
That at least is the judgment of a stock-market indicator created by Vincent Deluard, an investment strategist at Ned Davis Research. Deluard calls it "the best indicator you've never heard of."
I first wrote about this indicator two years ago. It's constructed by adding together the stock market's P/E and the so-called "Misery Index"— which itself is the sum of the unemployment and inflation rates. As you can see from the chart above, the stock market's historical performance has been far better when this indicator is lower than when it's higher.
The key insight on which this indicator is based is that P/E ratios should be interpreted in light of macroeconomic conditions. A low P/E isn't automatically bullish, for example, if it comes at a time which inflation and unemployment are high—such as in the late 1970s, for example. By the same token, a high P/E isn't automatically negative—if it's accompanied by low inflation and unemployment.
That is especially relevant right now, since — when looked at in isolation — the S&P 500's SPX, +2.43% current P/E suggests an overvalued market. But in the context of the current low level of the Misery Index, the market's current P/E doesn't appear to be out of line.
In fact, according to Deluard, his indicator currently stands at 25.0, which is well-below its historical median level of 26.5. That puts the current market's valuation in the quadrant that is historically associated with a 13.2% annualized gain for the S&P 500.
However, some P/E levels are so high that even low rates of inflation and unemployment cannot justify them. At the S&P 500's bull-market high on May 21, for example, Deluard's indicator stood at 27.0 — which is above the historical average and indicative of an overvalued market.
Some of you are wondering why I would now be writing columns with a bullish theme, given the bearish tone of my other columns in recent months. But challenging the prevailing consensus is the essence of contrarian analysis. While that consensus was extremely upbeat earlier this year, if not outright exuberant, it quickly turned to panic earlier this week.
Rest assured that, if and when the mood returns to euphoria, my columns will once again focus on reasons for questioning that exuberance —
Posted by: sarah_oz@yahoo.com
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